Updated: Jun 24, 2018
The Stock…just about to pay nice hefty dividends
Retired Tech Sergeant Cecil Martin was savoring a sip of his morning coffee. TSgt Martin and Sara had done well with saving as much as they could...until retirement.
Now the kids were grown, and they settled back home in a beautiful home they had paid for…some years ago. As he looked out the window of their breakfast room, he was pondering whether to work in his garden or go fishing. Instead, he decided to head to the Boy Scout Center where he volunteered to work with scouts working toward their Ranger Award in Fishing. He would tell the wife, “Well…as least I do good while I fish.”
The Phone Call
His thoughts were interrupted when his cell phone buzzing and sliding across the breakfast table. It was a call from an advisor. This guy wanted him to buy shares of a sector Mutual Fund that was known for hefty dividends and he had in on good authority that it was just about to pay them out. The broker suggests he think about it and to call him back in 24 hours. As he was walking out to head to the Scouting center…he mentioned it to Sara. Her response was, “Honey, buying a stock just cause it about to pay a dividend…is that legal?”
Is it legal?
No, it is not legal. Dividend selling is a dishonest broker tactic that involves convincing a client to purchase a stock because it is about to pay a dividend. Typically, it is a retired or elderly client. The trade is a commission driven transaction purely in the broker's best interest because of the commissions it will generate.
Here is why the recommendation is dishonest. Once a stock is trading ex-dividend, its price decreases approximately by the amount of the dividend, so the investor does not come out ahead . Sometimes if the market thinks that the stock dividend should have be higher…the price could go lower. Clearly not in the Martins best interest.
Investopedia makes a very valid point. It states that dividend selling makes the investor worse off. The investor has lost the commission paid, and commissions to full-service brokers who make stock recommendations are expensive. Dividend selling by a broker may also harm the investor because he could be left with a stock of a company that he knows nothing about and may be unsuitable for his investment objectives and risk profile.
General Electric (GE) stock…of one of the world’s largest companies is a great example of what happens if you encounter an advisor with gifts of dividends. Just think of how the Martin’s would have felt if the mutual fund they purchased invested heavily in GE Stock. Shortly afterwards, the stock made the headlines. The headlines read:
“GE's Stock Falls After Moody's Says 'Mounting' Challenges Outweighs Dividend Cut Benefit
Shares of General Electric Co. GE, -1.63% slumped 1.2% in afternoon trade Monday, after Moody's Investors Service said the industrial conglomerate's "mounting end-market challenges" outweigh any boost to cash flow from the halving of the dividend. The stock is suffering its fifth loss in six sessions, to shed 12.2% since the industrial conglomerate revealed its turnaround plan on Nov. 13. At that time, GE said it was cutting its annual dividend to 48 cents a share from 96 cents. Moody's said in an issuer comment Monday that it expects the "severe deterioration" in GE's power business to last at least through 2019. The rating agencies also expects continued weakness in GE's oil and gas business, while its transportation business grapples with weak for freight locomotives. Last Thursday, Moody's downgraded GE's credit rating to A2 from A1, while affirming the short-term Prime-1 rating. GE's stock has plunged 26.7% over the past three months and 43.1% year to date. In comparison, the Dow Jones Industrial Average DJIA, -0.34% has gained 8.1% the past three months and 18.5% this year.”
Increased Tax Liability
Lastly, when the Martins receive their dividends, either in cash or even if they reinvest them, the dividends are added to their taxable income for that year. So now they could possibly have increased taxes and a loss of wealth. The broker however is fine. He or she has made their commission.
Be wary of Greeks bearing gifts
The Martins are better off investing in Mutual Funds or stocks that are suitable and after the ex-dividend date of the investments and avoid the taxable event.
In the epic retelling of the legend of the Trojan War, the Roman Poet Virgil coined the phrase, “Be wary of Greeks bearing gifts. ” That was a warning that a gift carries a hidden threat. Be wary of Brokers and Advisors ‘Selling Dividends.”
References and Resources
Dvidend Selling |Investopedia |https://www.investopedia.com/terms/d/dividend-selling.asp#ixzz5IjPdh0lb
GE's Stock Falls After Moody's Says 'Mounting' Challenges Outweight Dividend Cut Benefit| MarketWatch on: Nov 20, 2017 3:30 p.m. ET
Why Ancient Rome Matters to the Modern World | Mary Beard: Fri 2 Oct 2015 The Guardian Books